If you are a freelancer or considering becoming one, you probably have questions about what kinds of tax deductions you can take.
How you are taxed as a freelancer depends on the structure of your business:
Sole Proprietorships. The sole proprietorship, in which the business is owned and managed by an individual proprietor, is a common structure for freelancers. Bottom line: You are the company, and as the owner, you pay taxes on business income as part of your personal income tax.
Limited Liability Company (LLC): An LLC protects a freelancer from personal liability, but it has a more flexible management structure than a corporation. An LLC can choose how it wants to be taxed—as a sole proprietorship, S corporation or C corporation. Profits and losses are reported on the owner’s individual tax return if the business is a sole proprietorship or S corporation.
S Corps and C Corps: Because a C corp is the costliest and most complicated form of business, the structure is not popular (or necessary) for freelancers. However, if you plan to make more money than you would have made at an equivalent full-time job as an employee, an S corp allows you to split your profits between your employee wage and distributions of profits from your business. The employee wage portion is taxed at the higher self-employment rate, but the remainder is treated as distributions of profits from your business.
The good news: Being a freelancer allows you to claim most of the same deductions as a larger business. In general, you can deduct the costs of running your business. The IRS deems a business expense deductible if it’s both ordinary and necessary. An ordinary expense must be common and accepted in your field of business. A necessary expense must be helpful and appropriate for your business.
Here are the most common tax deductions you can take as a freelancer:
Startup expenses: If you started your business in the calendar year for which you’re filing taxes, you can deduct expenses related to startup such as research, marketing, equipment purchases, etc. You can even deduct the costs of startup if you didn’t start in that year, as long as you were buying or starting a specific business. If you were researching several business ideas, however, you cannot deduct those expenses.
Home-based business: To take the home office deduction, you must meet two general rules: A portion of your home must be set aside for the exclusive use of running your business and must be your principal place of business. If you meet these requirements, you can use the simplified method or deduct the portion of your home expenses attributable to running your business, including utilities, security, mortgage/rent and any home improvements related to your business. Talk to your tax expert and check IRS Publication 587 for more details.
Self-Employment Health Insurance Tax Deduction: Under Section 2042 of the Small Business Jobs Act, self-employed individuals can take a deduction for the cost of health insurance. This deduction is taken into account in calculating net earnings from self-employment. See Form 1040 and Schedule SE instructions for calculating and claiming the deduction.
Transportation: You can deduct costs associated with transportation to and from meeting with clients, running business errands such as buying supplies, attending seminars and meetings and more. If you use your own car for transportation, keep a log and receipts for costs associated with the business use of your car, such as mileage, maintenance, repairs and fuel.
Travel: Travel expenses associated with the running, marketing and sales of your business are deductible, including plane and train fare, car rental, hotel stays, tips, meals, dry cleaning and phone bills.
Entertainment and gifting: You can deduct no more than $25 per business gift you give directly or indirectly to each person during the tax year. If you give a general gift to a company and then one to a person in the company, you can still take only one deduction. Incidental costs, such as engraving, packaging, insuring and mailing, are not included in the cost of a gift for purposes of the $25 limit. To deduct entertainment expenses, you must be able to prove the entertainment cost was directly attributable to the expectation of a business benefit.
Charitable contributions. Businesses must follow very specific rules when it comes to charitable contribution deductions. Most contributions are considered business expenses, so check with your tax expert on how to claim these contributions.
Education: As a freelancer, you can deduct expenses for qualifying work-related education directly from your self-employment income. This reduces the amount of your income subject to both income tax and self-employment tax.